On Exchange Trading Versus Over The Counter

Financial markets are organised in two basic ways: on exchange or over the counter (OTC), with the traditional distinctions blurred slightly by some recent electronic facilities.

Exchanges started as physical locations where
trading took place. Some of the most famous exchanges include the New York
Stock Exchange (NYSE) which was formed in 1792 and the London Stock Exchange
(LSE) which was founded in 1571. There are currently more than 100 stock and
derivatives exchanges around the world.

Exchanges govern trading and related information and
set institutional rules. They are closely linked to clearing facilities which
deal with post-trade activities. An exchange will act as the central point for
the communication of bid and offer prices to all direct market players, who
will respond by agreeing to buy or sell at one of the prices quotes or by
coming up with a counter offer. The medium of communication differs from
exchange to exchange but can be voice, hand signal, electronic message or
computer-generated electronic commands. When two parties reach an agreement on
the price, the transaction is executed and communicated throughout the market.

Electronic trading has eliminated the need for
exchanges to be physical places. In fact, many trading floors are now closing
with the communication or orders and executions being managed electronically.
The London Stock Exchange is now completely electronic.

Contrary to exchanges, over the counter (OTC) markets
have never been physical localities. They are less formal networks of trading
relationships that focus around one or a group of dealers. The way in which
over the counter trading works is that dealers quote prices at which they will
buy or sell to other dealers and to their clients. They don’t need to quote the
same prices to dealers as they do to clients, and they do not have to quote all
clients the same price. Dealers can withdraw from market making at any time
which can disrupt the ability of participants to buy or sell. OTC markets
operate with fewer regulations than exchanges and are less transparent.

In the world of crypto, Coinbase, the popular US cryptocurrency
exchange, launched an OTC trading desk for institutions to get cryptocurrency
exposure in November 2018. The start-up was recently valued at US$8 billion.
Its OTC trading is done directly between two parties instead of on exchange,
with Coinbase acting as an “agency” earning commission by executing client
trades.

Christine Sandler, Head of Institutional Sales at
Coinbase, said of the launch that the move was made in conjunction with an
increased demand for OTC crypto trading from institutional investors. “We
launched our OTC business as a complement to our exchange business because we
found a lot of institutions were using OTC as an on-ramp for crypto trading.”

Elsewhere, cryptocurrency finance firm, Circle
Trade, has an OTC desk with a minimum entry-point of US$250,000 and is backed
by Goldman Sachs. Here principal trading desks utilise their own inventory to
complete orders and provide liquidity for clients. Circle said it executed
10,000 OTC trades in 2018, accumulating US$24 billion in notional volume.

Last year, cryptocurrency exchange Bittrex launched
an OTC trading desk allowing investors to trade up to 200 digital assets.
Bittrex said it would offer guaranteed pricing for large block trades starting
at US$250,000.

Bittrex CEO, Bill Shihara, said in
a statement to the media that the OTC service would “further advance the
adoption of blockchain technology worldwide, while providing high volume
traders with much needed price certainty and a fast and easy way to trade large
blocks of digital assets.”

Gemini, which was founded by Cameron and Tyler
Winklevoss and Genesis Trading offer further OTC trading options for
cryptocurrencies. US-based digital asset platforms, Bitfinex and Poloniex, also
have OTC trading desks dedicated to large volume traders.

OTC trading is popular with institutional investors who trade substantial volumes of cryptocurrencies. The upside being that OTC trades are often handled via brokers who offer high-volume traders an option to execute large trades with lower fees and a faster settlement.